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Can Stocks Keep Defying Logic? Rising US Dollar, Yields May Challenge Rally

Published 07/11/2024, 04:34 pm
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So, Trump won the election as expected. Yesterday also marked the completion of the implied volatility reset that began yesterday, with the VIX 1-Day dropping from around 30 to 15 and the VIX index falling from 20.5 to 16.6.

Naturally, this sent stocks higher, and the typical reaction we see during implied volatility resets.VIX-1-Hour Chart

The most significant moves were in the FX and rates markets, with the 10-year yield climbing by 16 basis points to close around 4.44%, breaking above the long-term downtrend that began in October 2023.

We need to see follow-through today, but this could lead to a 10-year rise to around 4.6% in the near term.US 10-Yr Yield-Daily Chart

The even more significant move was inflation expectations, which rose by ten basis points, pushing the 10-year breakeven rate to around 2.4%.US Breakeven 10-Year Yield Chart

We also saw the US dollar strengthen significantly, with the dollar index rising by over 1.5% on the day. Higher rates contribute to a stronger dollar, and at this point, a stronger dollar is likely unfavorable for hard assets.US Dollar Index-Daily Chart

This explains the gold (XAU/USD) drop, which broke a significant uptrend in mid-August.XAU/USD-Daily Chart

Copper also fell 5% on the day as well.

Copper Futures-Daily Chart

International stocks underperformed yesterday, likely due to the strengthening U.S. dollar and rising interest rates.ACWX-Daily Chart

Logic Need Not Apply

We see two contrasting images of the market: rates and the dollar negatively impact risk assets. However, U.S. stocks managed to avoid this yesterday due to mechanical moves.

As for the S&P 500, it’s hard to predict what comes next because while logic can be applied to almost every other instrument—and even to the presidential election—the S&P 500 seems to be in a league of its own, where logic, fundamentals, technicals, or anything else need not apply.

S&P 500 Futures-Daily Chart

Most of the move in equities seemed to be driven by market mechanics, as evidenced by the significant drop in the IWM 1-week 100% moneyness option implied volatility (IV).IWM Price Chart

Predicting stock market movements for today is challenging, especially with the upcoming Federal Reserve news conference. Since the initial rate cut, we’ve seen significant increases in both rates and inflation expectations.

I believe the Fed is expected to cut rates today to save face. A further cut in December seems improbable. The equity market’s reaction to these developments remains uncertain.

It’s important to note that the current environment differs from the post-2016 election period. Back then, the global economy was teetering on deflation, with the ECB and BOJ implementing negative interest rate policies and extensive quantitative easing.

U.S. growth and job creation were sluggish, with unemployment at 5%. Stocks traded at approximately 15 to 16 times 12-month forward earnings, compared to yesterday’s 22 times.

At that point, Trump’s pro-growth policies were a pleasant surprise. Given the state of the debt and the deficit, it isn’t clear to me at this point if it will be treated as kindly by investors.

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